If your IRA or 401(k) owns an active business structured as a pass through entity (such as an LLC or partnership), you owe UBIT.

If your 401(k) owns mortgage-leveraged real estate AND the mortgage is a “seller carry”, you owe UBIT.

UBIT, or Unrelated Business Income Tax, applies to tax exempt organizations including retirement plans. To pay UBIT, Form 990-T must be filed with the IRS. If this is all news to you, once you are done scolding yourself, you may want to file for an extension using Form 8868.

If you talk to the average CPA, he’ll tell you that UBIT is the boogeyman and is to be avoided… always. Discussing this topic with an above average CPA (such as Eric Wikstrom of Integrated Wealth Strategies) yields different advice.

The Two Types of UBIT

Triggered from a trade or business – if a tax exempt entity (such as an IRA or 401k) owns a trade or business, the income of that business is taxed at trust rates (i.e. very high tax rates). Both IRA & Solo 401k accounts are subject to this type of UBIT.

Triggered from ownership of leveraged real estate – if a tax exempt entity (including IRA) owns real estate leveraged with a mortgage loan, the portion of that income attributable to the mortgage loan is taxed at trust rates. This type of UBIT is specifically referred to as UDFI – Unrelated Debt Financed Income. Solo 401k accounts & other qualified plans are exempt from UDFI.

Trust tax rates are very high, so it might make sense to avoid Type 1 UBIT at all costs. On the other hand, a close examination of UDFI tends to revoke its “boogeyman” status.

The reason UDFI isn’t a detrimental cost is that non-recourse mortgage loans (the only type an IRA/401k can legally obtain) are typically only offered at a 65% loan-to-value maximum. So this means that the UDFI tax is only payable on up to 65% of the property’s net income. (That’s right – net income. You do get to deduct depreciation and other expenses before paying UDFI tax).

Let’s examine a simple comparison of the taxes payable on net real estate income with 50% leverage: [Read more…]

5500-EZ for Solo 401(k) plans

If your Solo 401(k) plan assets exceeded $250,000 in value in 2007, a 5500-EZ must be filed by July 30, 2008. This is an informational return used to report plan value to the IRS and does not require any tax payment.

990-T for IRAs with mortgage financed real estate

If your IRA owns mortgage leveraged real estate, a form 990-T should have been filed with UBIT payment by April 15, 2008. Unrelated Business Income Tax is one an IRA must pay on the portion of income or gains attributable to the mortgage leverage used. For example, if your IRA owned a property with a 50% debt to basis ratio, then 50% of its income would be taxable at trust rates. While many investors balk at the idea of paying taxes on IRA profits, a tax analysis in most scenarios typically favors paying UBIT over making the same investment with non-retirement funds.

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